The funding process is a very critical component in the survival and success of a startup and deserves good knowledge and experience of this domain. I will try to cover some high level points which any startup founder or entrepreneur should be aware of.
1. Funding is the Lifeline of a Company
Any business can go bankrupt if it does not have enough funds to keep paying it’s bills. Securing appropriate funding is the foremost job of a CEO. And normally in the life of a startup, this funding could be 25%-50% of 1 experienced person’s job. It entails, dealing with various investors, getting references and introductions, cold calling, creating investor profiles and finding the suitable ones, pitching, working on term-sheets, legal documents, financial models etc. So have this as one of the focus areas for at least 1 co-founder, or C level executive, possibly the CEO or CFO.
2. Funding Life cycle
Typically a startup would have various rounds of funding at different stages of its growth. Depending upon the life-cycle of your startup, you may deal with following mechanisms of funding,
– Customer financing: Some customers may buy your story and want to help you succeed so they can benefit from your product / service. It’s typically the best way to raise money as you get a customer who help finance you, be the first customer, and also guide you in product development.
– Seed / Angel Investors / FFF round: these are relatively friendlier people (maybe friends / family .. avoid in-laws) who believe the in founder(s) capability to execute a business plan. Many of them don’t expect too many returns (or any returns for that matter). They typically invest very early around the idea stage. FFF stands for friends, family and fools
– Professional Investors (Venture Capitalists etc.): these investors come after the company has been built, and has been in operation for few quarters to few years. The startup would have proven the product, service and business model. At least it would have a proto-type of the product and / or a few customers. Such investors would be called early stage investors. Subsequently in later rounds of funding (called Series B, C etc.), there come VCs who invest post-revenue stage. Institutional funding is typically expensive, it comes with lots of conditions and strings attached. If you can run your business without this, highly recommended to do so. Typically institutional investors would not care much about your business / product / passion to change something, but they would look at it only from a return on investment perspective.
– Private Equity: they invest into companies where they can expect a good growth, or they see a potential for turning around a not so well performing company (typically by changing the management), or if they see the company can expand into various more things with bit more experience and ambition. They typically would look to invest at least $20mm and possibly lot more.
– IPOs: Initial Public Offering means listing your company on a stock exchange and having its shares offered to retail investors. There are certain requirements imposed by different regulators (SEBI in India) and exchanges (NSE, BSE, etc.) before a company can do its IPO. It certainly needs to have a few years of strong revenues and be willing to open deal with the administrative processes (around shareholders, reportings’, meeting various regulatory guidelines’ etc.) Each funding round has its own challenges, terms & conditions, and dilution that need to managed carefully by the management of the startup. Practical advice is to learn and understand this process from some people who have gone through it, so you can manage yours better.
3. It takes Time to Raise Funding
It takes a lot of time to raise funds. Typically speaking, if you are starting your company now, and you have raised some seed investment from friends and family that is sufficient to keep going let’s say for 6 months – 1 year, then you need to start meeting the next round investors like professional investors (seed funds, VCs etc.) from now. It will take you time to meet them, talk about your business plan, get their feedback (whether they would be keen on investing into your company at some stage) and build relationship with them. If 6 months later you back to them, show them progress in your business and ask for funds, it’s an easier conversation. And don’t get over confident if somebody commits the capital verbally. Until it’s in your account, it’s not done. So do keep talking to many professional investors (and no need to name either of them to each other) and keep your choices open. Use all sources (all of your team’s network) to get access to investors. Strong relationships can be beneficial. It’s better to approach investors with some introduction, cold-calling is not the best way; though in worst case it could be tried as well. One benefit of trying to meet investors early on is also that they would give you some feedback on your business that could be very constructive. Be open to any criticism as well. Also do chose your investors carefully. Go for investors whom you feel you would like to work with (most probably, for any major investment, a professional investor will take a board seat in your company).
The valuation at which an investor invests is important, its equally important what terms go with it. The term-sheet is very critical and you must get legal help (your own lawyers) to know and understand what each term means and what you feel it should be. Consider if you want to issue pure equity, convertible debt, along with some preference options etc. If you have followed the step 3 well, and your business is interesting and you have managed to keep many investors interested in your business, then you can play them against each other and get a good valuation and terms. Either ways, be reasonable, fair and professional. You will have subsequent funding rounds in which the value (in an ideal case) should always go up. Else you will have some troubles with your previous round investors.